I used that Star Trek inspired title in a Commentary last April, in a warning that this wouldn't be a typical cyclical recovery, and we're seeing evidence currently of the unique economic aftermath of the historic credit bubble that imploded less than 2 years ago. There are growing concerns that the U.S. risks a Japanese post-bubble scenario of endless economic stagnation, as reflected in tumbling implied inflation expectations in the TIPS market. The yield on 2-yr Treasury Notes yesterday dropped to its lowest level ever and as short-term Treasury yields typically track the nominal GDP growth (they effectively present a risk-free alternative to having 'geared' nominal GDP exposure via equities and corporate debt) current levels suggest that the market is expecting an extended period of recessionary conditions and inflation well under 2% over the next few years. Treasury yields seem to be pricing in the double-dip recession that many economic bears have been calling. The 10-year annualized growth in Japanese M2 has dropped to just 2% (from 8% back in 1990) and the downward trend in Japanese M2 growth has been accompanied by exceptionally low interest rates. Trend Japanese real GDP growth has been slowing and has not hit the 2% level since 1997 and has consistently been below the combination of trend growth in the Japanese labour force and the rate of growth in workforce productivity.  In other words, Japan has underperformed even its grim demographics because of financial sclerosis.

Although trend U.S. M2 money supply growth is currently nothing like as weak as that of Japan, on a y/y basis growth has fallen to just under 2%, reflecting the recent contraction in U.S. commercial bank credit. Weak U.S. money and bank credit growth is occurring in the Japanese context of very low official interest rates and the transmission mechanism between the Fed and the economy via the credit system remains dysfunctional. The US banking system is not transforming the effectively ‘free’ money offered by the Fed into credit for the private nonfinancial (and particularly small business) sector of the U.S. economy. The current recovery has been unusual in being led  by the top 5% of households by income and spending by large business, when typically small businesses lead hiring and income growth to pull the US economy out of recession. The core problem is that the smaller regional banks which dominate small business lending are in much weaker shape than the Wall Street giants.   Commercial and industrial loans have declined by 4% and real estate loans have contracted by 2% since the beginning of 2010, while bank holdings of Treasuries have risen by 3%.